Ahsan Habib: Rethink macroeconomic policies

Sunday

Nov 10, 2013 at 9:00 AM

By Ahsan Habib

Last week, the Federal Reserve decided not to taper the monetary stimulus it started several years ago as the whole world awaited the decision. The Fed, headed by Ben Bernanke, is one of the most powerful entities of the world. It is natural to analyze the causes and consequences of such power.

A century ago, the idea of governments intervening to remove cyclical unemployment was absent. The dominant economic view was that an economy is capable of maintaining full employment.

The Great Depression changed that and the federal government began to undertake active programs to create jobs and help the economy. Economist John Maynard Keynes gave theoretical support to that idea. Most significantly it legitimatized budget deficits during cyclical unemployment. The assumption was that budget surpluses during better years would restore fiscal balance.

Keynesian economics was a dream come true for politicians. They immediately embraced the idea that federal spending can remove unemployment. The Employment Act of 1946 was created to legitimatize budget deficits during periods of high unemployment. Congress, however, failed to mandate an offsetting budget surplus during recession-free years. Consequently, the U.S. economy experienced more deficits and few surpluses during the next 60 years. Since 1958, the U.S. national debt has increased every year except for a negligible drop in 1969.

This fiscal irresponsibility undermined the fundamental strength of the U.S. economy and the economic crisis of 2007 emerged. Since then, the federal government took a series of wrong moves and our economic vulnerability increased.

The first mistake was calling it a recession. The recession Keynes identified was a situation caused by a drop in demand. But economic downturns can also be created by weakness in the production sector, often referred as supply side economics to distinguish it from the demand-focused analysis of Keynes. All macroeconomic textbooks state that the Keynesian strategy will fail when the economy is faced with supply side problems.

The second mistake was the failure to make a proper analysis of the crisis. Instead, the government blindly applied Keynesian tools that were politically expedient. Congressmen and the president are not qualified economists. They will not unilaterally spend money to build a rocket destined for the moon; they will engage NASA. But in this case, they entertained countless questionable spending programs. One such program was "Cash for Clunkers." I questioned its value in this newspaper in 2009. Several new studies have indicated that the program achieved very little, as reported this week by The Washington Post. The advice of politically neutral economists are sadly absent from post-2007 responses.

The third mistake was engaging the Fed for help. The focus of the Fed has been diverted with dual mandates from the specialized job of maintaining monetary stability to a vague and larger task of stabilizing the whole economy. In essence, federal government officials have turned to the Federal Reserve for help when their own policies have proven ineffective.

The fourth mistake is really a series of mistakes which I have discussed before in this newspaper. It appears that the Fed is completely clueless. This is demonstrated by the wide range of strategies on interest rate and monetary supply it has adopted, and by its constant wavering on deadlines. Anytime unfavorable economic data arrives, the Fed changes its time frame.

Despite six years of massive fiscal and monetary stimulus, the net result is not very impressive. This is evident because supporters are afraid to cut back their programs, fearing re-emergence of the crisis. In other words, the policies have not worked and they would rather keep the economy on life-support for an indefinite period of time.

Continually weak employment data corroborates the failure. The unemployment rate has gone down mainly because many people dropped out of labor market. The unemployment rate known as U6 counts these workers and part-time workers to give a more accurate picture. That rate was around 8 percent in 2005-07. It averaged 10.5 percent in 2008 but jumped beyond 16 percent for 2009 and 2010. In October 2013 it was still 13.2 percent.

Also, the percentage of people working was greater than 63 percent in 2006-08. It fell to 58.9 percent in 2009 and was just 58.3 percent according to employment data released this week.

It is often said that Bernanke was a student of the Great Depression and he learned that failure of the Federal Reserve to increase money supply aggravated the problem. But he may also consider that perhaps it was because the Fed was conservative at that time the economy maintained its internal strength to withstand the excesses of the federal government and the Fed for the next 75 years.

Maybe Bernanke's initial actions were necessary, but their endless continuation is worrisome. Today's economy, punctuated by too much interference and support from Washington, may be unable to show the resilience it's shown in the past.

Ahsan Habib is a professor and Economics Department chair at Adrian College.